Greening the Financial System: The first step towards a sustainable future

27 October 2021

In recent years, and even more so within recent months, there has been an increased attention towards climate change. Innovators, founders, and CEO’s all over the world are trying to come up with new sustainable solutions to tackle this great challenge of our lifetime – but where do we begin? “You can have a lot of great ideas to fight climate change, but the money to fund it, the real strength, comes within the finance track,” says Michael Sheren, Senior Advisor at the Bank of England.

With the release of the United Nations’ climate report in August 2021, which declared Code Red for human driven global heating, more people are starting to realize the urgency of climate change. With the UK pledging to be net zero carbon by 2050, a profound challenge is set upon every part of society to adapt in order to become more sustainable. By 2025, no new buildings will be heated by gas, and by 2030, it will no longer be possible to buy a vehicle that is not electric – leaving lots of stakeholders in society with new challenges in making more sustainable decisions.

The financial system is the core of a sustainable future
Normally, economies develop step by step. Now, as there is a prompt need for the entire global economy to change, society needs to climb up the ladder a lot more quickly than before. “Whether you’re a small company, an SME, or a large corporation, you need to re-do your plans. Everything you see, whether it’s a car, a bus, or a building, needs to be retrofitted to become more sustainable or be completely substituted. What this actually means for production companies, is that they need to make changes in their production facilities and models and these changes come in the form of capital expenditures to build new sustainable factories, which in turn, is financed by banks. That is what green finance is all about, that is why green finance is so important,” says Michael.

Michael emphasises that banks must play a crucial role in greening the financial system. Sitting in the middle of this huge web of companies and organisations that characterise our society, banks hold the unique opportunity to make real impact by funding the changes in the real economy. “If you are a bank, you must look at who your clients are and start to speak to them about how they can make more sustainable choices. If you are a central bank, you can help by speaking to the banks and insurance companies you regulate and help them to understand the risks in a high carbon economy, and how they in turn can speak to their real economy clients to transition their business models. This is how central banks can start to transform and green the whole financial system.”

Financial community recognises climate change as an important risk
About seven years ago, Michael worked with Mark Carney, the former governor of the Bank of England, and many other senior members of the Bank of England, who all started recognising a strong link between financial risk and climate change; they could see how more frequent extreme weather conditions and transitional risks could have a huge effect on the financial sector. “The homes and cars that are getting washed away have mortgages and leases on them. Therefore, when a home or car is damaged due to severe weather, the bank that holds the loans and mortgages on these assets (and the insurance companies that insure them) are also under threat. So, when you think about it, the financial industry and the central banks have a huge amount of vested interest in how real economy assets are affected by climate change,” Michael says.

The Bank of England started several climate initiatives in 2015, both domestically and globally. One of these initiatives was a report on the risks within the insurance industry in relation to climate change. The report gained a lot of attention and was recognised globally. “We received a great amount of interest from the Chinese Central Bank, as well as from the United Nations and many other groups around the world, and that was a key initiative that really accelerated the Bank of England’s journey in the area of climate risk,” Michael says.

New opportunities in relation to G20
When the Chinese Central Bank reached out in 2016, China was just about to take over the presidency of the G20 conference. “For the first time, they only wanted to add one new item to the agenda, which ended up being called the G20 Green Finance Study Group (GFSG). The group was placed in the G20 finance track, which is a track consisting of central banks and finance ministers. I had the great privilege to co-chair this group together with my counterpart from the People’s Bank of China, Dr. Ma Jun, who was their chief economist. It was just an outstanding opportunity that elevated climate risk within the G20 and gave us a platform to start talking to other central bankers and finance ministers within the G20,” says Michael.

About the same time as the G20 happened, Mark Carney launched the highly impactful Task Force on Climate-Related Financial Disclosures, as Chair of the Financial Stability Board. The Task Force, chaired by Michael Bloomberg, was set up to drive the process for companies to disclose their carbon footprints. From the advancements with the G20 GFSG and the TCFD, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), was formed. “I would argue, from a small kernel of some work that we did in the Bank of England for our domestic audience around insurance, it all grew very quickly. I’m very proud that the Bank of England recognised this risk early on, and that we helped inspire others in other countries. Now, six to seven years later, you can’t turn on a television or read a paper without understanding or seeing the threats to climate change,” Michael says.

Can a company be both sustainable and profitable?
Even though making profound changes to the way companies run their operations can seem like a huge obstacle, Michael believes it can be the business opportunity of a lifetime. When asked if it is possible for organisations to make green decisions and still stay profitable, Michael is certain: “There will be some winners and there will be some losers, but those banks and organisations that start recognising this quickly and start making real and smart changes, those are the companies who will come out from this with more opportunities than ever.”

By 2040, about 44 million homes in the UK will have to install heat pumps, instead of being powered and heated by gas boilers. Michael views Sweden as a role model when it comes to efficient homes. “Sweden has been a real global leader in efficiency, both in terms of their housing stock, their buildings, and how they heat them. The whole world could learn from Sweden on this.”

With a transition that complex, many opportunities arise. “The jobs that are going to be created in changing how homes and commercial building are heated are going to be profound. First of all, taking out all the old gas-powered combination boilers will require a number of skilled plumbers that we simply do not have, so we need to train people. Then, when taking out the boilers, we can’t just crunch them up and throw them into a hole – semi-skilled workers will be needed to take the copper, aluminium, and plastic out so it can be reused. We used to call that recycling, but we didn’t actually recycle everything. Now, it is a bigger concept, and that concept is called a circular economy,” says Michael.

When starting to change an entire economy, new jobs are created in taking down the old economy, recycling the old and building new, sustainable solutions. “If you are a company, start putting those glasses on and you will be able to view your industry in a completely new perspective. All of a sudden, you will see the opportunities, investors will see it, and managers and the boards will see how to change their companies. In that way, it will create jobs which contribute to growing a green economy. Not only is the green economy going to be a profitable one, I would argue that the brown economy is going to be a very dangerous one to be investing in and to be a part of even in the near future,” says Michael.

How companies can adapt in four steps
So where does a company start? According to Michael, the first step is to figure out what your carbon footprint is – how many tonnes of carbon is burnt a year to make the products or to deliver services. Once that is measured, you follow the guidelines of the Task Force on Climate-Related Financial Disclosures to disclose the measurement. “If you don’t know how much carbon you generate a year you’re shooting in the dark. The four steps are to measure it, disclose it, come up with a business model that is more sustainable, and then execute on that plan. If I was a company right now, I would take those four steps as quickly as possible.”

Technology is crucial in a green future
In order to make this profound transition into a new green economy, technological development will play a crucial role. “Technology is what is going to help us, it is what is going to take companies from that carbon intensive, environmentally degradative business model, into a new environmentally smart plan. You see it in every sector, but one major area is agriculture; one example is vertical farms, which are extraordinary. If you power them with either wind or solar technology, you can basically do up to 26 crops a year for some plants, while using 90% less water, and they’re often more nutritious than the ones you would grow outside,” says Michael.

Michael emphasises that there are endless opportunities for many sectors to develop new, sustainable, and environmentally smart solutions. “If you have an open mind, technology can actually change the entire way you think about your transportation, your food, your housing, your mobility, and most importantly, your sources of energy.” However, there are four sectors in which he believes have the most potential: agriculture, mobility, real estate, and energy. “Those are the four industries I would focus on because they are key. Everyone needs shelter, everyone needs food, everyone needs to get around and everyone needs energy to power themselves.”

About Michael Sheren
Michael Sheren is a Senior Advisor within the Bank of England. He provides counsel and independent challenge to senior management on matters concerning, governance, financial markets, and risk. Mr Sheren Co-Chaired the G20 Sustainable Finance Study Group, is a member of the NGFS and an Senior Advisor on climate finance to the UNDP. Further, Mr Sheren is an active developer of innovative sustainable finance structures around the world. Mr Sheren was a founding contributor to the BoE’s Fintech Accelerator and remains on its steering committee and is active in supporting and mentoring Greentech companies. Prior to Joining the Bank, Mr Sheren was an investment banker and spent over twenty-five years in the debt capital markets in New York and London. Mr Sheren holds master’s degrees from Harvard, The London School of Economics and NYU.